Chapter 02 Basic Financial Statements True / False Questions The sale of additional shares of capital stock will cause treasury stock to increase True False A business entity is regarded as separate from the personal activities of its owners whether it is a sole proprietorship, a partnership, or a corporation True Assets need not always have physical characteristics as buildings, machinery, or inventory True False The going concern principle assumes that the business will continue indefinitely True False False Notes payable and accounts payable both require a company to pay an amount owed by a certain date Notes payable generally have interest, while accounts payable generally not True False 2-1 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Any business event that might affect the future profitability of a business should be reported in its balance sheet True False The practice of showing assets on the balance sheet at their cost, rather than at their current market value is explained, in part, by the fact that cost is supported by objective evidence that can be verified by independent experts True False Liabilities are usually listed in order of magnitude, from smallest dollar amount to largest dollar amount True False The entity principle states that the affairs of the owners are not part of the financial operations of a business entity and should be separated True False 10 The accounting equation may be stated as "assets minus liabilities equals owners' equity." True False 11 Total assets plus total liabilities must equal total owners' equity True False 2-2 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 12 A transaction that causes an increase in an asset may also cause a decrease in another asset, an increase in a liability, or an increase in owners' equity True False 13 The collection of an account receivable will cause total assets to decrease True False 14 The payment of a liability causes an increase in owners' equity True False 15 When a business borrows money from a bank, the immediate effect is an increase in total assets and a decrease in liabilities or owners' equity True False 16 The purchase of an asset, such as office equipment, for cash will cause owners' equity to decrease True False 17 Total assets must always equal total liabilities plus total owners' equity True False 18 If a company purchases equipment with cash, its total assets will increase True False 2-3 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 19 If a company purchases equipment by issuing a note payable, its total assets will not change True False 20 A net profit results from having more revenues than liabilities True False 21 A statement of cash flows reports revenue and expense activities for a specific time period such as one month or one year True False 22 It is not unusual for an entity to report a significant increase in cash from operating activities, but a decrease in the total amount of cash True False 23 The statement of cash flows provides a link between two balance sheets by showing how net income (or loss) has changed owners' equity from one balance sheet date to the next True False 24 Articulation between the financial statements means that they relate closely to each other on the basis of the same underlying transaction information True False 25 Limited liability means that owners of a business are only liable for the debts of the business up to the amounts they can afford True False 2-4 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 26 In a business organized as a corporation, it is not necessary to list the equity of each stockholder on the balance sheet True False 27 The owner of a sole proprietorship is personally liable for the debts of the business, whereas the stockholders of a corporation are not personally liable for the debts of the business True False 28 Window dressing occurs when management attempts to make a company look financially stronger than it actually is True False 29 Decision makers outside the organization base their credit decisions on weekly, or even daily, financial statements True False 30 The major outgrowth from business failures and allegations of fraudulent financial reporting during the 1990's was the passage of the Securities and Exchange Act True False Multiple Choice Questions 2-5 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 31 Which of the following is the primary objective of an income statement? A Providing managers with detailed information about where the enterprise stands at a specific date B Providing users outside the business organization with information about the company's financial position and operating results C Reporting to the Internal Revenue Service the company's taxable income D Indicating to investors in a particular company the current market values of their investments 32 Which of the following describes the proper form of a balance sheet? A The heading sets forth the period of time covered B Cash is always the first asset listed, followed by permanent assets (such as land and buildings), and finally by assets such as receivables and supplies C Liabilities are listed before owners' equity D A subtotal for total assets plus total liabilities is shown 33 A balance sheet is designed to show: A How much a business is worth B The profitability of the business during the current year C The assets, liabilities, and owners' equity of a business as of a particular date D The cost of replacing the assets and of paying off the liabilities at December 31 2-6 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 34 Blue Wholesale Shirt Co sold shirts to Pink Retail Shoppe The owner of Pink Retail said she would pay Blue at a later date, which Blue Wholesale agreed to Blue Wholesale Shirt Co is considered to be a: A borrower B liability C creditor D debtor 35 Which of the following best defines an asset? A Something with physical form that is valued at cost in the accounting records B An economic resource owned by a business and expected to benefit future operations C An economic resource representing cash or the right to receive cash in the near future D Something owned by a business that has a ready market value 36 From an accounting viewpoint, when is a business considered as an entity separate from its owner(s)? A Only when organized as a sole proprietorship B Only when organized as a partnership C Only when organized as a corporation D A business is always considered as an accounting entity separate from the activities of the owner(s) 2-7 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 37 The accounting principle that assumes that a company will operate in the foreseeable future is: A Going concern B Objectivity C Liquidity D Disclosure 38 The valuation of assets in the balance sheet is based primarily upon: A What it would cost to replace the assets B Cost, because cost is usually factual and verifiable C Current fair market value as established by independent appraisers D Cost, because in the event of liquidation, the assets would be sold at an amount equal to their original cost 39 Which of the following is not a generally accepted accounting principle relating to the valuation of assets? A The cost principle - in general, assets are valued at cost, rather than at estimated market values B The objectivity principle - accountants prefer to use objective, rather than subjective, information as the basis for accounting information C The safety principle - assets are valued at no more than the value for which they are insured D The going-concern assumption - one reason for valuing assets such as buildings and equipment at cost rather than at their current market values is the assumption that the business will use these assets rather than sell them 2-8 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 40 Each year, the accountant for Southern Real Estate Company adjusts the recorded value of each asset to its market value Using these market value figures on the balance sheet violates: A The accounting equation B The stable-dollar assumption C The business entity concept D The cost principle 41 The owner of Westhampton Fish Eatery purchased a new car for his daughter who is away at college at a cost of $43,000 and reported this amount as Delivery Vehicle in the restaurant's balance sheet The reporting of this item in this manner violated the: A Cost principle B Business entity concept C Objectivity principle D Going-concern assumption 42 Eton Corporation purchased land in 1998 for $190,000 In 2014, it purchased a nearly identical parcel of land for $430,000 In its 2014 balance sheet, Eton valued these two parcels of land at a combined value of $860,000 Reporting the land in this manner violated the: A Cost principle B Principle of the business entity C Objectivity principle D Going-concern assumption 2-9 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 43 Bob Bertolucci, owner of Bob's Bazaar, also owns a personal residence that costs $575,000 The market value of his residence is $725,000 During preparation of the financial statements for Bob's Bazaar, the accounting principle most relevant to the presentation of Bob's home is: A The concept of the business entity B The cost principle C The going-concern assumption D The objectivity principle 44 Which of the following will not cause a change in the owners' equity of a business? A Purchase of land with cash B Withdrawal of cash by the owner C Sale of land at a profit D Losses from unprofitable operations 45 Which of the following is correct when a corporation uses cash to pay for an expense? A Total assets will decrease B Retained earnings will increase C Owners' equity will increase D Liabilities will increase 2-10 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education AICPA FN: Measurement AICPA FN: Reporting Blooms: Apply Difficulty: Medium Learning Objective: 02-04 Explain how the statement of financial position; often referred to as the balance sheet; is an expansion of the basic accounting equation Topic: A Starting Point: Statement of Financial Position 136 Preparation of balance sheet Prepare the balance sheet as of December 31, 2014, for Gamma Company, from the following list of items which are arranged in random order You must compute the amount for accounts payable to complete the balance sheet AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement AICPA FN: Reporting Blooms: Apply 2-146 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Difficulty: Medium Learning Objective: 02-04 Explain how the statement of financial position; often referred to as the balance sheet; is an expansion of the basic accounting equation Topic: A Starting Point: Statement of Financial Position 2-147 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 137 Preparation of balance sheet after a series of transactions The balance sheet was as follows for Custom Ceramics on February 1, 2014: During the first week of February, the following transactions occurred: * The business used cash to pay off $5,000 of its accounts payable (No payment was made on the notes payable.) * Additional capital stock was issued to Joan Custom for $15,000 cash * Equipment was purchased on credit for $1,800 * The business collected $4,000 cash from accounts receivable Complete the balance sheet for Custom Ceramics as of February 8, 2014 2-148 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Feedback: (a.) $7,000 + $4,000 + $15,000 - $5,000 = $21,000 (b.) $5,200 - $4,000 collected = $1,200 (c.) $30,000 + $1,800 = $31,800 (d.) $6,000 + $1,800 (equipment purchase) - $5,000 paid = $2,800 (e.) $126,200 + $15,000 (additional investment) = $141,200 AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement AICPA FN: Reporting Blooms: Apply Difficulty: Medium Learning Objective: 02-04 Explain how the statement of financial position; often referred to as the balance sheet; is an expansion of the basic accounting equation Topic: A Starting Point: Statement of Financial Position 2-149 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 138 Completion of balance sheet Use the following information to complete the balance sheet of Adelphi Construction as of December 31, 2014 (1) The company was organized on January 1, 2014 and has operated for the full year 2014 (2) Earnings were $275,000 and dividends of $70,000 were paid to stockholders (3) Cash and accounts receivable together amount to one and one-half times as much as notes payable Feedback: (a.) Total assets must be $620,000 to agree with the total of liabilities plus owners' equity (b.) Cash must be $5,000 to achieve a total asset figure of $620,000 2-150 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education (c.) Cash ($5,000) plus accounts receivable ($85,000) equals $90,000 This total is stated to be 1.5 times the amount of notes payable Notes payable is computed as $90,000 divided by 1.5, or $60,000 (d.) Accounts payable must be $115,000 to achieve total liabilities figure of $215,000 (e.) Retained earnings at the end of the first accounting period must be earnings ($275,000) less dividends $(70,000), or $205,000 (f.) Capital stock must be $200,000 to achieve total liabilities and owners' equity figure of $620,000 AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement AICPA FN: Reporting Blooms: Apply Difficulty: Medium Learning Objective: 02-04 Explain how the statement of financial position; often referred to as the balance sheet; is an expansion of the basic accounting equation Topic: A Starting Point: Statement of Financial Position 2-151 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 139 Completion of balance sheet Use the following information to complete the December 31, 2014 balance sheet of Copper Supplies Company (1) Owners' equity as of January 1, 2014, totaled $175,000, which included capital stock of $150,000 (2) Additional capital stock was issued during 2014 in exchange for $40,000 cash (3) Net income for 2014 amounted to $200,000; no dividends were paid during 2014 (4) Cash and accounts receivable together amount to times as much as accounts payable Feedback: (a.) Total of liabilities & owners' equity must be $835,000 to agree with the amount of total assets (b.) Cash and accounts receivable together amount to times accounts payable, or $120,000 2-152 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Since cash is $30,000, accounts receivable are $120,000 - $30,000, or $90,000 (c.) Equipment must be $200,000 to achieve total assets of $835,000 (d.) Beginning capital stock is $150,000 + stock issued of $40,000 = $190,000 (e.) Beginning retained earnings (175,000 - 150,000) + net income of 200,000 = 225,000 (f.) Total liabilities must be $420,000 to achieve the total of liabilities plus owners' equity of $835,000 (g.) Since total liabilities are $420,000 and accounts payable are $40,000, notes payable must be $380,000 AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement AICPA FN: Reporting Blooms: Apply Difficulty: Medium Learning Objective: 02-04 Explain how the statement of financial position; often referred to as the balance sheet; is an expansion of the basic accounting equation Topic: A Starting Point: Statement of Financial Position 2-153 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 140 Effects of transactions on balance sheet items Show the effect of each of the seven listed transactions on the balance sheet items of Distinctive Draperies Indicate the new balances after the transaction of May and each subsequent transaction The effects of the May transaction are already filled in to provide you with an example 2-154 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Medium Learning Objective: 02-04 Explain how the statement of financial position; often referred to as the balance sheet; is an expansion of the basic accounting equation Topic: A Starting Point: Statement of Financial Position 2-155 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 141 Effects of transactions on balance sheet items Show the effect of each of the six listed transactions on the balance sheet items of Renaissance Investment Services, Inc Indicate the new balances after the transaction of November and each subsequent transaction The effects of the November transaction are already filled in to provide you with an example 2-156 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Medium Learning Objective: 02-04 Explain how the statement of financial position; often referred to as the balance sheet; is an expansion of the basic accounting equation Topic: A Starting Point: Statement of Financial Position 2-157 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 142 An inexperienced accounting intern at Tasso Company prepared the following income statement for the month of July 2014: Instructions: Prepare a revised income statement in accordance with generally accepted accounting principles AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Blooms: Apply Difficulty: Medium Learning Objective: 02-05 Explain how the income statement reports an enterprise's financial performance for a period of time in terms of the relationship of revenues and expenses 2-158 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Topic: Income Statement 143 From the following accounts and amounts prepare a balance sheet for the Swell Company for December 31, 2014 You must compute the amount for retained earnings to complete the balance sheet AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Blooms: Apply Difficulty: Medium 2-159 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Learning Objective: 02-04 Explain how the statement of financial position; often referred to as the balance sheet; is an expansion of the basic accounting equation Topic: A Starting Point: Statement of Financial Position 144 Forms of Business Organization State and describe the three most common forms of business organizations in the United States (1) Sole Proprietorship - One person, unlimited liability, and owner acts as manager (2) Partnership - Two or more persons and owners are personally responsible for debts (3) Corporation - Stockholders are owners, limited liability, ease of transfer of ownership, and separate entity under the law AACSB: Reflective Thinking AICPA BB: Legal AICPA FN: Reporting Blooms: Remember Difficulty: Easy Learning Objective: 02-08 Explain common forms of business ownership-sole proprietorship; partnership; and corporation-and demonstrate how they differ in terms of their statements of financial position Topic: Forms of Business Organization 2-160 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education ... the principal on a bank loan B Purchase of a delivery truck on credit C Sale of land on credit for a price above cost D Borrowing money from a bank 52 On the statement of financial position,... make a company look financially stronger than it actually is True False 29 Decision makers outside the organization base their credit decisions on weekly, or even daily, financial statements... $575,000 The market value of his residence is $725,000 During preparation of the financial statements for Bob's Bazaar, the accounting principle most relevant to the presentation of Bob's home is: A